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Limelight Networks, Inc. (LLNW)

Q3 2009 Earnings Call

November 04, 2009 4:30 pm ET

Executives

Jeffrey Lunsford - Chairman and Chief Executive Officer

Douglas Lindroth - Chief Financial Officer

Paul Alfieri - Senior Director, Corporate Communications

Analysts

David Hilal - FBR Capital Markets

Michael Olson - Piper Jaffray

Kerry Rice - Wedbush Morgan Securities, Inc.

Derek Bingham - Goldman Sachs

Chad Bartley - Pacific Crest Securities

Donna Jaegers - D.A. Davidson

Srinivas Anantha - Oppenheimer & Co.

Michael Turits - Raymond James

Sameet Sinha - JMP Securities

Operator

Good day ladies and gentlemen and welcome to the third quarter 2009 Limelight Network earnings conference call. At this time, all participants are in a listen-only mode. At the end of the prepared remarks we will provide instructions for those interested in entering the queue for the question-and-answer session.

I would now like to turn the call over to Paul Alfieri, Senior Director of Corporate Communications. Go ahead, Paul.

Paul Alfieri

Thank you for joining the Limelight Networks’ third quarter 2009 financial results conference call. Speaking today will be Jeff Lunsford, Chairman and Chief Executive Officer, and Douglas Lindroth, Chief Financial Officer.

This conference call is being recorded on 4 November, 2009, and will be archived on our website for approximately one week. Some portions of this conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are all statements that are not strictly statements of historical facts, such as statements regarding future events or future financial performance, including, but not limited to, statements related to Limelight Networks’ market opportunity and future business prospects, guidance on financial results, statements concerning anticipated future growth and profitability, as well as management’s plans, goals, strategies, expectations, hopes and beliefs.

These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those contained, projected or implied in the forward-looking statements including the inherent risks associated with litigation particularly intellectual property base litigation. Reported results should not be considered an indication of future performance. Factors that could cause actual results to differ are included in the Company’s periodic filings with the Securities and Exchange Commission.

I would now like to introduce Jeff Lunsford.

Jeffrey Lunsford

Thank you all for joining us. Today, Limelight Networks reported $32.5 million in revenue for the third quarter of 2009. During the quarter gross margins expanded by 1 percentage point and adjusted EBITDA remains steady. Operating highlights in the quarter included the launch of Limelight’s next generation XD platform with the depth of intelligence which provides advance levels of performance, an increase insight into real-time internet and delivery conditions. And the launch of the LimelightREACH and LimelightADS, two new services that provide [current] capabilities for customizing and monetizing media delivery on mobile and other connected devices.

The internet continues to transform, advance the way people live, work and play around the world. Tomorrow’s internet will involve more real-time dataflow and content consumption across a growing mix of computers, laptops, netbooks, game consoles, televisions, set-top boxes, and mobile devices, the combination of which will allow consumers to enjoy content, access information and conduct transactions at any time from any place.

With our XD platform and mobility monetization solutions we are positioning Limelight Networks to be a core provider of club-based services within this transformed world. Helping forward-thinking media, entertainment, enterprise and government organizations leverage the next generation internet capabilities to differentiate from their competitors and better serve their constituents.

The $1.4 billion CDN market is healthy and continuous to grow. This market operates in two distinct segments. First the large object segment where media and technology companies use CDNs to deliver large video, music and software files. Second, small object segments, where all types of companies use CDNs to deliver their entire websites including small files like GIFs and JPEGS and to accelerate and enter transactions that involve dynamic data.

In addition to these two markets, the CDN is an attractive supporting platform for many value-added services that can be delivered over the internet otherwise known as cloud-based services. Limelight’s strategy is to 1) to continue to build and distinguish ourselves as the most capable high-performance CDNs in the large objects space which is our traditional area of strength, 2) Expand capabilities with Limelight’s XD and future services that [Inaudible] penetrate the small object enterprise markets, and 3) launch higher margin value-added services such as LimelightREACH and LimelightADS that leverage our high-performance CDN platform.

At present our business was gaining traction along all three of these growth factors. At the end of Q3, our customer count was approximately 1,307 which include mobility and monetization solutions customers. We signed contract with over a hundred of new customers in the quarter but also continue to attrite less attractive ones. The value of our customer relationships increased slightly in the quarter as average, annualized revenue per customer grew to $95,000 in the quarter. We are pleased with our overall bookings performance which is an increase over Q2.

While the large object market is characterized by higher volumes and greater price pressure, this segment continues to be important as it is where we get our scale. It is also the segment where we forged new ground of innovative customers utilizing new, advanced consumer-oriented technologies. During the quarter we added our expanded relationship with customers in this segment such as Nintendo in the gaming sector, AVG and Checkpoint in the software sector, [Puver] and Jango in the digital music sector.

National public radio and the online radio sector and Channel 4 in the UK in the online television sector. Our small object capabilities are growing rapidly also albeit from a small base, and we are signing up more customers for whole site small object and other enterprise related services each quarter. During the quarter we are pleased that companies such as overstock.com, blog talk radio, the Knot, teli bluebook, Nightcon, and online marketer maximize the selected Limelight site and Limelight deliver to power their online businesses.

Since its launch we have signed approximately 20 customers for Limelight site’s services and we are optimistic about the growth prospects for this service going forward particularly with the anticipated launch of site 2.0 early in 2010. Our value added services are also growing from a small base. These include mobility and modernization solutions, highly specialized consulting services and other services we have in the works for launch in 2010.

In the third quarter average traffic levels continue to rise and we again experienced new records for peak traffic on the network. In October, Arbor Networks published their latest Atlas observatory study, which estimates total internet traffic at approximately 14 terra-bits per second. The report names Limelight Networks as one of the internet hyper giants along with companies such as Google and Facebook. As one of the next generation networks which are gaining traffic share from traditional telecommunications providers.

Now I would like to turn to more operational highlights. Just after the end of Q3, we announced our XD Platform. XD represents a complete upgrade of the entire command and control software layer that operates our little network. Using patent pending innovations built by the Limelight engineering team over the past two years, XD positions as well for the future in four key opportunity areas, delivery, storage, analytics and computing. While today we compete mainly in the delivery market, XD provides us with the foundation to expand in the other attractive value added services. One of the key innovations the XD platform provides is the ability for our network to T-path the edge server and get a real time view of last mile network and end user device conditions. The XD platform can also automatically tune object delivery on a per connection basis in real time.

This helps us insure a brilliant user experience across a wide variety of devices even under sub-optimal or changing network conditions. We believe the capability we gained from the XD platform to actively manage delivery after an end-user has connected to a Limelight edge server will provide us with a competitive advantage in the new world where myriad access devices are connecting to content sources over a myriad of dynamic internet connections. Additionally just after the close of the quarter we announced another key global telecom reseller relationship with leading carrier in Canada, Bell Canada. Global telecom companies increasingly want strong CDN capabilities in their portfolio. But this is a complex business that requires a great deal of capital investment and technical expertise.

We believe that as a network base CDN, Limelight can offer telecommunication providers a unique model for partnership. At the core of the relationship with Bell is deep technology integration between Bell’s optic network within Canada and Limelight’s global delivery platform software. This deep integration enables Bell to immediately enter the Canadian market with a proven industry leading Limelight service running locally over their network. Bell can immediately expand their product portfolio at higher value CDN services as well as an array of applications from the Limelight eco-system such as content hosting ad-insertion and performance monitor.

For Limelight, this close coupling with Bell’s network gives us extended reach throughout Canada as well as the benefit of the sales team with deep local knowledge and existing relationship. We also gain greater insight into the internet traffic patterns of Canadian broadband users which lets us consider to refine and improve delivery.

I will now turn the call over to Douglas who will take you to the financial and other key points.

Douglas Lindroth

During the third quarter we reported revenue of $32.5 million up 1% compared to revenue of Q2 and down 2% from the same period last year. We reported third quarter adjusted EBITDA of $5.8 million compared to $6 million for Q2 and $5 million for the third quarter last year. Our adjusted EBITDA increased to 18% of sales from 15% in the same period last year and flat the last quarter. Our GAAP net loss was $5.2 million or $0.06 per basic share compared to a net loss of $15.4 million or $0.18 per basic share in the same period last year. We also reported a third quarter non-GAAP net loss before stock based compensation and litigation pass of approximately $600,000 or $0.01 for basic share compared to a non-GAAP net loss of approximately $700,000 and $0.01 per basic share last quarter. Please refer to the tables included in our press release for a reconciliation of GAAP measures to these non-GAAP measures.

During the third quarter, Limelight’s international operations represented 22% of total revenue, which was an increase from 19% in Q2. Gross profit margin, which includes both depreciation and stock based compensation, was 36% during Q3, up from 35% last quarter and Q3 of 2008. Cash gross margin was 56% for Q3 flat to last quarter and down from 57% in the same period last year.

As Jeff highlighted earlier, we once again set new records for peak traffic on our network and we believe our ability to maintain our margins in a challenging economic and pricing environment is evidence that Limelight Networks has a global scale to continue to be one of the market leaders.

Our gross margins did not decline to the extent previously guided as we are successful at using our global scale and network-based architecture to reduce delivery. However, at the midpoint of our revenue guidance for the fourth quarter of 2009, we anticipated gross margin compression of approximately one to two points from Q3.

We expect to see a sequential decline in our gross margins primarily as a result of network expansion activities that took place during Q3 and will continue into Q4, partially offset by lower average delivery cost. During the third quarter, our operating expenses were $7.1 million, an increase of approximately $500,000 from last quarter and down $11.3 million from the same period last year.

Our operating expenses increased from the last quarter as a result of having a full quarter of Kiptronic expenses and due to an increase in our sales and marketing costs. Our operating expenses decreased from the same period last year due to a decrease in litigation costs, damage accrual and bad debt expenses.

We anticipate that our fourth quarter operating expenses excluding litigation cost will increase by approximately $1.7 million. The forecasted increase is primarily the result of additional headcount in our sales organization, increased marketing programs and an increase in bad debt expenses.

Total depreciation and amortization for the third quarter was $6.6 million, down from $6.7 million in the second quarter and down from $7 million in the same period last year. Depreciation and amortization in the current quarter includes $6 million of network related depreciation.

Stock based compensation expenses for the quarter were $4.4 million compared to $4.3 million last quarter and the same period last year.

Third quarter interest earnings were approximately $300,000 compared to approximately $300,000 for Q2 and $1.2 million for the same quarter last year. The reduced interest income is associated with lower market interest rates and lower average cash balances from the same quarter last year.

Moving on to the balance sheet, our combined cash and marketable securities balance on September 30 was $152.8 million, down from $164.3 million in the second quarter. The decrease in cash and marketable securities is primarily related to our capital expenditures and large contract prepayment we made to one of our global network providers. The prepayment was related to our backbone expansion as well as a long-term bandwidth purchase agreement. Capital expenditures for the third quarter were $10.6 million compared to $5.3 million for Q2 and $7.9 million for the same quarter last year.

As we previously guided, our capital expenditures increased in Q3 as we continued to expand the scale and capacity of our network. Days Sales Outstanding for the quarter were 77 days, up from 73 days in the previous quarter.

Regarding guidance, for the fourth quarter of 2009, we expect to achieve revenues in the range of $32.5 million to $34 million. As I mentioned, we expect one to two points of gross margin compression at the midpoint of our guidance range and we expect the operating expenses, excluding litigation cost, to increase approximately $1.7 million. Stock based compensation expenses for Q4 are expected to be approximately $4.4 million and capital expenditures are expected to be in the range of $5 million to $6 million.

With that I will turn it back to Jeff.

Jeffrey Lunsford

Thank you Douglas, at this time operator, we will open the line for questions.

Question-and-Answer session

Operator

(Operator instructions) Your first question comes from the line of David Hilal of FBR Capital Markets. Please proceed.

David Hilal - FBR Markets

Jeff first on the net customers’ flat sequentially, obviously two drivers there, the churn and gross customers adds, can you talk about those two pieces that make up the net number?

Jeffrey Lunsford

Yes, sure. A little more color on bookings so the, we continue to work through, we would characterize as higher-than-normal churn, smaller companies primarily. They are just having difficulty with the tough market conditions. And, we however, saw, as I mentioned, a very solid bookings quarter and in a sort of two ways to think of bookings. One is monthly minimum revenue and then our market segment has also shifted to where folks were making the annual bucket commitments. So we think about that as an annual contract value rather than a monthly contract value. And we had a nice increase in the annual contract value from quarter to quarter so we felt like from the forward looking indicator, bookings were positive but we are still working through a) raising the bar on the quality of customer, driving down BSO and b) trying to focus on the higher quality of enterprises where we can cross-sell and up-sell value-added services to expand our product portfolio.

David Hilal - FBR Markets.

So maybe talk about that Jeff as it relates to guidance so bookings sounds like were pretty decent and deferred a nice sequential move and then you will get CapEx was more than you had planned to stand which is usually the predictor of maybe what you guys are seeing in the pipeline? For your guidance it is kind of mediocre CapEx, so maybe you can reconcile that.

Jeffrey Lunsford

Well, yes so. CapEx was pretty light in the first half of the year and our build outs were somewhat lumpy. So I would not read too much into just having a large Q3. If you look at it for the first three quarters it is probably about the right pace. And as we always do with our guidance, we are going into any quarter we have about 55% of our minimum or above revenue on the contract and the other 45% to 50% is variable based on usage. So this is not sort of 90+% visibility [SAPS] business that you and I were used to David, it is a little more opaque and we are trying to provide the right level of forward guidance given what we have today.

David Hilal - FBR Markets.

Okay and then finally, Microsoft in your Qs you always give us a little more detail and I wanted to understand maybe you could tell us now what Microsoft contribution was in the quarter? And specifically that trended down last quarter and I am wondering how that is and what will be the trend going forward?

Jeffrey Lunsford

They were 15% of revenue during the quarter.

David Hilal - FBR Markets.

Okay and then going forward…

Jeffrey Lunsford

It was flat last quarter.

David Hilal - FBR Markets.

How do you think that trend is going forward?

Jeffrey Lunsford

Well on a macro, multi-year basis, Microsoft, we helped them build an in-house CDN and so you should assume and they have been publicly talking about shifting I think the last thing they said was they want 60% of their traffic drawn on their own CDN in 2010. I believe that was the number but do not quote me on that, you need to fact-check that. And so overtime, Microsoft will decrease in size as a percentage of Limelight’s revenue and that is been the plan, by design, all along. Now we are in there as a very we think, solid partner of Microsoft’s, working with them on multiple fronts and we are going to do anything we can to continue to be primary service provider to them for the traffic that they do not deliver over their own CDN.

Operator

(Operator Instructions) Your next question comes from the line of Mike Olson of Piper Jaffray, please proceed.

Michael Olson – Piper Jaffray

You said international was 22% of revenue, up from 19% in Q2, you have the, what the international revenue growth rate was on year-over-year basis?

Jeffrey Lunsford

Year-over-year is about 33%.

Michael Olson – Piper Jaffray

Okay and then on the expense side, G&A has been running in a low 20s as a percent of revenue for the last couple of quarters after being in a high 30s or 40s in ’08. Is this kind of a new run rate for G&A and is in the low 20s? Is that fair to assume?

Jeffrey Lunsford

Yes, I am going to think what I would look at it and we are only guiding to next quarter and the one thing that I put in my prepared remarks, talk about increasing in Q4 potentially for higher bad debt expenses. So we have had two quarters in a row where I believe our team across the borders has done a really good job working with our customers and collecting on receivables. So as we have been able to do that, where we are booking some very large bad debt expenses, Q4 of last year and Q1, we feel that we had a good reserve or an allowance for bad debts and therefore did not require a lot of additional bad debt expenses. So we are forecasting that to increase in Q4 just to be back to more of the normalized run rate.

So other than that, we do planned over the long term to leverage our G&A as we continue to grow. So we should see continued leverage and G&A expenses not growing as a percentage of sales.

Michael Olson – Piper Jaffray

Okay and then last one, just Pete talked generally about the pricing environment and how you are expecting pricing to trend over the next couple of quarters?

Jeffrey Lunsford

We saw the same kind of year-over-year price range that we saw last quarter, I think we said between 30% and 35% and that is if you take our traffic revenue and divide it by the bits or GBs delivered, gigabytes delivered. So we continue to believe that there has been sort of a structural re-pricing in the industry and that in 2010 and potentially even in this quarter we should see a slow and gradual return to the more historic norm of 20% to 25% year-over-year price declines rather than the 30% to 35% that we are working through today.

But that is another one of those that is reasonably opaque and when you look at price list in our industry as volume grows, their unit price, they get a lot of benefit of scale. And so it is really hard to just look at the date set because when you factor in the growth of each customer, one customer might get 60% better pricing the next year. But if they are 200 times larger that does not mean that prices in the industry went down 60%.

Operator

(Operator Instructions) Your next question comes from the line of Srinivas Anantha of Oppenheimer, please proceed.

He is no longer in the queue, your next question comes from the line of Kerry Rice of Wedbush, please proceed.

Kerry Rice - Wedbush Morgan Securities, Inc.

Just a couple of questions, I think about your guidance and one is what changed I guess from last year Q4 because you saw a nice ramp up in Q4 in revenue and arguably in a deteriorating economy and in this quarter or in Q4 and maybe we will start with that. And then the second part is when you announced your Q2 guidance or earnings, you said that pricing had kind of reverted back to this kind of historical norm of 20%, 25%, so I was going to see what happened between July and in the end of the quarter now that you are saying there was a 30% to 35% decline in Q3?

Douglas Lindroth

Yes and I do not believe we had said that it had reverted back on our last earnings call. We had talked about that we saw during Q2 the 30% to 35% year-over-year type of price declines. I am not sure where you are getting that. We have been seeing those similar types of price declines and price competition within the market certainly over the last six months.

Jeffrey W. Lunsford

Yes I think we did give the color commentary last earnings call about, we felt like in the back half that we would hopefully see a return to the more historical norms but we did not see that this quarter, if that is what your question refers to.

Kerry Rice - Wedbush Morgan Securities, Inc.

Somewhat, I will have to go back and pull out where I saw that. But maybe then what has changed between this Q4 and last Q4 that you are not kind of seeing that same pop that you did. Is it simply a pricing issue? Because it sounds like traffic is growing pretty good.

Jeffrey W. Lunsford

I think what I would say is last Q4; we had three of four things that happened in the quarter that were nice over performance events. If you look back at to our guidance last Q4, I think our results were nicely ahead of the guidance range and there were three or four pretty substantial half a million to million dollar revenue events that happened in the quarter that led us to perform in Q4 of 2008.

Kerry Rice - Wedbush Morgan Securities, Inc.

Okay and then one final question. You talked about churning some of the maybe a less attractive customers, when do you think you will get through that process because you have been churning these kind of less attractive customers for at least for a couple quarters now. Do you see an end to that in the next quarter or in the near term?

Jeffrey W. Lunsford

I think it is hard that is like asking us to [divide] on the economy. There is just a higher percentage in normal businesses that are struggling while these online guys who raise some capital when markets are hot and now cannot get their B and C rounds of funding, folks like that. It is just hard to say. What we have definitely done is raised the bar of the quality of customer we will accept to begin with and tighten the range on payment requirements and just trying to focus on being disciplined on that matter.

Operator

Your next question comes from the line of Derek Bingham of Goldman Sachs. Please proceed.

Derek Bingham – Goldman Sachs

Question on traffic, when you think about year-over-year traffic growths maybe on a per customer basis, are you seeing anything of those on your network accelerate or are things been pretty stable.

Jeffrey W. Lunsford

I would say stable year-over-year traffic growth. You have to take it customer by customer. We have some customers where you can clearly see their business model as gaining traction and they are showing very solid growth. We also have, as you know Derek, most of our larger customers use us in a multi CDN architecture so sometimes we could see traffic growth and it is just because we are getting more share of their traffic allocation. But all in all we are still seeing general growth across our customer base.

Derek Bingham – Goldman Sachs

Okay but there is not kind of an early signs of an inflection upward that you see so far associated with increasing bit rates or something like that. It has been kind of a steady pace of high growth.

Jeffrey W. Lunsford

Yes.

Derek Bingham – Goldman Sachs

Okay. In terms of how your unit pricing, for bandwidth has trended versus the unit price declines that you see on the revenue line, your cash gross margin has been stable so maybe that is the answer there. But is there any reason to believe this relationship will change looking ahead one way or the other?

Jeffrey W. Lunsford

We think at scale, it is part of our investor presentation we have. Our target model is about a $300 million revenue run-rate. We think we can be running it about 45% gross margins which would be some rate points higher than today. That is really the benefit upscale as you get a broader customer base, you feel more values of inactivity with traffic and thus paying customers and you really do not have any incremental costs across the platform for those customers and so you do see the ability to run the network at higher overall level utilization which helps drive that margin. Also launching and getting traction with these value added services which are higher margin than the traditional, which is of course; CDN business should help us there as well.

Derek Bingham – Goldman Sachs

Okay and just one more if I could. On the service provider relationships or relations with Hosters or other kind of channels, could you talk about how that is trending maybe as a percentage of your revenue or any other color you could give on anticipating more of these types of relationships in becoming a more important part of you business?

Jeffrey W. Lunsford

Yes. So channels are definitely growing as the percentage of revenue. We do not really break it out as a separate reporting line. But we have been asked a couple of large telecommunications providers and as we said in our comments, there is a pretty natural fit there. Most of these folks do not want to go off and try to get into this business themselves. It is a very complex software oriented business. So there is this very good synergy especially Limelight being a network CDN so that is clearly a channel that is promising for us and we do have relationships with Hosters as well. That area is a good leverage point for a company like Limelight. It is looking for greater distribution opportunities.

Operator

Your next question comes from the line of Chad Bartley of Pacific Crest. Please proceed.

Chad Bartley – Pacific Crest Securities

I wanted to ask a follow up on pricing, I appreciate you guys quantifying the declines you are seeing. Jeff last quarter you talked about the Telco specifically kind of driving that and being more aggressive on price. Obviously Akamai has talked about a slightly different strategy on price. Can you give us an update on the competitive landscape and Telcos being more aggressive, Akamai being more aggressive. Who is driving that acceleration and that decline?

Jeffrey W. Lunsford

You really sort of have to take it account by account Chad, because certain accounts have certain needs and gravitate towards baking us off against whether it is a telecom provider or a competitor like Akamai. If you look at our gross margins they have maintained in the mid 30s here. The buy side in our business is sophisticated especially the larger buyers and they understand our costs. They know we are building faster servers including software efficiency and driving on our own bandwidth cost, because these guys also buy raw transit. I think it is more of an industry thing and the comment on the telecommunications providers is that they actually get to have the ability to monetize delivery in two ways. Whereas we just get paid for the, what is called the on ramp to the internet. They actually get paid by an ISP that might be buying form of productivity from them if you are the provider. So we have a way to subsidize their CDN offerings slightly and that is the sort of the systemic re-pricing that we have talked about for a couple of quarters here that we think has flowed through the market and should we think subside, because we are now comparing our year-over-year numbers to pricing that was affected already by the entry of Telco’s into the market which really happened about three years ago.

Chad Bartley - Pacific Crest

A quick follow-up then, specific to Akamai, they talked about a change in their strategy last quarter. I do not know if it exactly played out on the pricing side as they thought or many of the investor’s thought. Did you notice the change in their pricing strategy in Q2 or in Q3 or they have been pretty consistent?

Jeffrey Lunsford

We think that we have had fierce competition with Akamai for eight years and that there was nothing dramatic a change, from our perception about their behavior last quarter.

Operator

Your next question comes from the line of Donna Jaegers of D.A. Davidson please proceed.

Donna Jaegers - D.A. Davidson

Just a few quick ones, on the international, the 33% year-over-year gain, what were the drivers for that? How much of that was currency benefits?

Jeffrey Lunsford

The currency piece was very little. The majority are international revenue today as denominated in U.S. dollars, so it is a small piece on the currency side.

Donna Jaegers - D.A. Davidson

Great, so the 33% growth and is there anything in particular driving that?

Jeffrey Lunsford

No, just continued good customer expansion throughout both Europe and Asia. So the market has been performing well. We have expanded some of our network expansion activities earlier in the year was bringing up more servers in locations in Europe and I think with better network performance drives more traffic and ultimately more revenue.

Donna Jaegers - D.A. Davidson

Great, great and then on the XD platform, I was curious if you could talk about the number of beta customers that are testing that and sort of those normal sales cycle that you would expect for that product.

Jeffrey Lunsford

Sure, we have had between five and ten; I do not have the exact number of customers trying various components of the XD platform. XD is an entire platform and this is as you know complicated system and so, we might have some customers testing one feature and other customer is testing another feature of the platform and sale cycles are 90 days to six months in this business. Folks, internet content delivery have become mission critical. Their customers expect either flawless experience if it is streaming video or music just like they did over the television.

So our customers are very careful when they are shifting traffic to a new platform and to the new commerce customer, any kind of transaction disruption obviously is very serious. So this is now a mission critical business and platform shifts take a little bit of time, people test them thoroughly and then when they see something they like, they will migrate traffic to it over time.

Donna Jaegers - D.A. Davidson

Then just one last quick one, legal expenses Akamai, I think, appealed last quarter, although I have not seen the details in their Q yet, can you talk a little about that appeal and any sort of spending increases that we should expect on your part?

Jeffrey Lunsford

We can only sort of point to dates in the calendar and we think the hearing will be midyear 2010 but possibly a little earlier than that, we are just not sure and costs around the hearing will of course go up a little bit, but the good news is, if there is any good news for litigation is that the appeal processes and as expensive as the lower court litigation process.

Operator

Your next question comes from the line of Srinivas Anantha of Oppenheimer & Co. Please proceed.

Srinivas Anantha - Oppenheimer & Co.

Jeff, when I am looking at your domestic revenue, it seems to be defining and it is still both on the sequential and year-over-year basis, if you were to break down that into pieces, is how much of that decline is being driven by churn and how much you suggest re-pricing your base, when contracts go on for renewal?

Jeffrey Lunsford

Yes, I think you would see this across the industry and I think it is pretty much pricing not so much churn. When you look at the customer count number, most of the churn is small customers that are not real material. We have not lost major customers in a continued pattern here at all. We preserved the bulk of our major customers and continue to grow market share within them but you are seeing the bulk of the price pressure in the CDN market is in the large object capital market that I talked about earlier which is really 90% of Limelight’s business.

Limelight’s business was 85% in the U.S. so when you compare us to others, you will see the same kind of year-over-year domestic revenue decline in other folks, if you have visibility into their businesses and it is very much driven by the year-over-year price compression.

Srinivas Anantha - Oppenheimer & Co.

On the CapEx, the last time we saw such a huge increase in CapEx, we saw a substantially nice increase in revenue in the subsequent quarter, so is this increase in CapEx and anticipation of some traffic commitments or traffic levels that you are expecting in 4Q and beyond?

Jeffrey Lunsford

Alright, so I think you might have dropped off from where we answered David Halal’s question to that effect, and it is really, you should just look at the blended first three quarters of the year. We were lighter on CapEx and normal in Q1 and Q2 and so Q3 was higher than normal, but if you look at the sort of the first three quarters, it is more of like a normalized run rate. Our CapEx just tends to be a little bit lumpy. So I would really look to more, look to the revenue guidance to think about how we are doing in Q4 not to the CapEx.

Srinivas Anantha - Oppenheimer & Co.

Got it, and in your prepared remarks, I think you have talked about such things with your value added services, could you quantify what percentage of your revenues are coming from value added services today and from what kind of verticals are you gaining traction on these services.

Jeffrey Lunsford

Sure Sri, it is not small enough to be meaningful today. In 2010, we are contemplating breaking it out as you can see some color there because we do think that that is something investors will want to know about, the growth rate and sort of the different margin profile, the services and the second question was on what types of markets?

Well the mobility and modernization solutions are largely, large media focus, helping large media companies and enterprises actually take content delivery over a mobile device wrapped in ads, so that it can be monetized. So we are seeing good traction there with large media companies around the globe, most of them are already Limelight customers, but a few them were mobility and modernization customers when we acquired that business.

I think another interesting area is virtualized storage, which is more of a core offering, we already been operating, but just selling through our existing customers and we are seeing growing interest in that as well. Then the consulting business, we have very talented folks who have a very specialized set of skills and as quickly as we can hire more talent, they get booked up. So that is a very promising area of the business also.

Operator

Ladies and gentlemen, please stand-by while we construct the Q and A roster.

Jeffrey Lunsford

I think you have Michael Turits next, operator.

Operator

Your next question comes from the line of Michael Turits of Raymond James.

Michael Turits - Raymond James

Last quarter you said that you thought that in the back half you have returned to sequential growth you did this quarter I think it was up 1% it seems like the midpoint of your guidance, it is about 2% sequentially. Is that about what you are looking for or it is still growth but it is still pretty modest? Is that what you expect in terms of the back half recovery or it is slightly less than and if so why?

Jeffrey Lunsford

Well, show we guided and we came out I guess in Q3 at the midpoint of our guidance range, I have to see that we have expected because we guided to that range and we would certainly like to be seeing greater growth, Michael and you know again, it is really a function of the pricing dynamic where we continue to see record traffic levels each quarter and I think you have seen our investors lag where we showed the graph of the traffic growth it is phenomenal and so it is really…

We think the return to higher revenue growth is going to driven by A when the pricing dynamic changes and reverts back to historical norms and B, as we get better penetration with these value added services. Those two things will allow us to get to top line growth back to where we would like to see it. Of course, 1% sequential is not, we know why we shouldn’t have to work every day. We would certainly like it to be a higher.

Michael Turits - Raymond James

What is the dynamic that makes it return to historical norm? What do you see that suggests that should stabilize at some point?

Jeffrey Lunsford

It was did discussion of the telecommunication providers and the impact they have on the market which is a one-time impact. It is just takes a while for that to float through all your customer contracts.

Michael Turits - Raymond James

And then I guess you have said that you were right when you return the sequential growth. When do you expect the domestic to actually return to sequential growth?

Jeffrey Lunsford

I would say it is really the same answer because the bulk of the things I described. We are still 78% of our revenues, domestic and we are still primarily in the large objects space while we are growing into the small object enterprise and whole site business that is growing from the small-base, so the answer I just gave you really applies to the domestic part of business.

Michael Turits - Raymond James

Okay. And on the gross margins you have said that you are looking for one and two points down this quarter, you kept it flat on cash and I guess it was up slightly on both cash and non-cash gross margins. Did you make less on an investment that would have had that kind of step-up in comps this quarter than you have anticipated and I know you get some efficiency also… But did you also invest less and spend less on a side that you expected?

Jeffrey Lunsford

Some of it was timing. When we do some of our expansion, when we bring-up a new location and new [co-lo] we ordered the equipment. The equipment then gets deployed on to whichever location and some of it is just timing from where we think when equipment going to first come in here to our warehousing operation for configuration and then get distributed out to whichever location that is going. So, often times it is just a timing issue and so we did think we are going to have more deployed and incur some additional [co-lo] and rack-type costs than we did in the quarter. So a lot of the equipment was here, it got deployed towards the end of the quarter, so we did not have it as much of the step up in the cost that we initially had thought going in into the quarter.

Michael Turits - Raymond James

So, it is hard to say if you had the same anticipated investment, would you add that one to two points there?

Jeffrey Lunsford

Yes, it is tough to say because again, it is just on timing and you know that is why we put it in to the one to two points for Q4. So, it is a little bit difficult but I think that is about right.

Michael Turits - Raymond James

I guess I want to sure what your guide was on this is, did you sense that after the OpEx moves-up from the bad debt expense in Q4? Does OpEx go down after that or OpEx is going to hold flat at that dollar level for a while?

Jeffrey Lunsford

It will as a dollar mat, It will increase over time as we grow, but I would expect to not be growing as a percentage of sales on a yearly basis. There will be times in a quarter, as it may toss around a little bit than more of a trend, we expect to see it to decline as a percentage of sales.

Douglas Lindroth

Thank you, Operator. At this time we have time for one more question.

Operator

Your next question comes in the line of Sameet Sinha of JMP Securities, please proceed.

Sameet Sinha - JMP Securities

Could you discuss pricing trends domestically and internationally? Do they tend to go locked step or are the dynamics different? That is the first question and I have a couple of follow-ups.

Douglas Lindroth

That question I would say that the international markets have a slightly less acute price pressure simply because different providers focused on different geographies and have different strengths and so it is easier to distinguish yourself and values so than the international market.

Sameet Sinha - JMP Securities

In terms of fourth quarter, I am just picking about the visibility in the fourth quarter. Do you get the general sense that most of your customers have their plans in place for the fourth quarter and they would not want to mess around with changing CD and services or making any sort of changes to their delivery systems in the fourth quarter?

Douglas Lindroth

That is definitely true of the e-Commerce vertical. It is not so true of software providers or some of the e-Commerce software provider but software providers in general, for software updates and games, software and media companies with that way the e-Commerce gets locked down usually around on October 1st.

Sameet Sinha - JMP Securities

Final question, can you speak about trends that you see out there in terms of video delivery and e-Commerce going to the fourth quarter? Are these trends generally what have been hearing, have been really positive in nature and maybe it is consumers sentiment coming back which benefits business sentiment. But when you speak to your customers what is the sense that you getting from them and maybe because your guidance sequential growth does not really exhibit that?

Douglas Lindroth

Well, our business is driven by consumer’s consuming content over the internet not so much by any business sentiment. Of course our contract negotiations are driven by business sentiment where customers are feeling bullish about their business. They will step-up and commit to more and again, I would tell you that our guidance reflects the facts as we have them and the visibilities that we have today regarding the fourth quarter.

Sameet Sinha - JMP Securities

Could you just remind us what were those 3 or 4 events that happened in fourth quarter of 2008 and provided those step comparisons?

Douglas Lindroth

I do not have those off the top of my head. I think we had a couple large consulting projects delivered and we might have had one or two live events that happened in the quarter.

Douglas Lindroth

Operator this time we thank everyone for attending and the calls conclude. Appreciate your joining.

Operator

Thank you for your participation in today’s conference. This concludes the presentation, you may now disconnect. Good day.

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Source: Limelight Networks, Inc. Q3 2009 Earnings Call Transcript
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